Why Am I Being Asked For My KYC?

Implementing Security Practices in DeFi on a Practical Level

With all of the exciting development and capital in the DeFi space, the jury is still out on how to implement the best safety and security practices while remaining decentralized. While the purpose of DeFi is to move away from the oversight and control that comes with centralized finance, there are many ways that DeFi continues to open itself to bad-actors in the space. The promise of a truly decentralized ecosystem is on the horizon, but in the meantime the most realistic version of DeFi includes borrowing some of the security elements of CeFi.

KYC is a form of identity verification

KYC (Know Your Customer) refers to the mandatory process that banks and other financial institutions use to gather identifying data and contact information from current and potential customers. The purpose of KYC is to prevent fraud, money laundering, and other illicit activity, as well as the misuse of financial accounts. KYC practices usually start before an individual becomes a customer since the financial institutions first need to verify the identity of a potential customer before opening an account.

KYC is absolutely essential to many crypto and financial institutions, which feels counterintuitive to the DeFi movement. Given that Defi aims to be censorless and accessible to all, requiring someone to validate and prove their identity is counterintuitive. As the boundaries between traditional finance and DeFi begin to blur, it is still up for debate whether or not KYC has a place in DeFi protocols, but let’s break down the pros and cons together.

KYC makes it safer for everyone to trade

KYC has been massively powerful in protecting individuals and institutions from bad-actors, fraud, and other illicit activity. Without this process in place, there is hardly a way to protect your assets online. DeFi has become a hub for money-laundering and fraud, as there are no safeguards put onto transaction monitoring. Earlier this year, the $200 million hack of Singapore-based major cryptocurrency exchange KuCoin was making headlines in the crypto world by running into this specific problem. This hack was unique compared to many others in the past because of the hacker’s blatant utilization of DeFi. KYC helps to protect institutions such as KuCoin from major hacks and illegal activity, but is a sticking point for purists who insist this isn’t “true DeFi.”

DeFi doesn’t work on its own yet

Given that the point of DeFi is for everything to be uncensored and non-traceable, it may seem like KYC doesn’t seem to have a place in DeFi. KYC directly goes against a decentralized and censorless system by requiring people to identify themselves, and possibly restricting access to those individuals based on their history or credentials.So why are some DeFi protocols still requiring KYC? Could you even consider the system decentralized at that point? Well, the short answer is that it’s a necessary evil at this juncture. Even if some form of KYC is used for different financial circumstances that require more regulation such as borrowing/lending, those who decide what is permissible in each jurisdiction and decide who is vetted to participate act as centralizing agents in the system and cumulate the power. This fragments the system because different jurisdictions may have a certain stance on what is legal/illegal, which causes the system to no longer be “borderless.”

Bridging the technology between DeFi and KYC

Many DeFi lending protocols such as Alkemi are striving to provide a safer way to lend and trade by building the bridge between CeFi practices and DeFi principles. Many of these protocols will require an initial KYC before you have access to an account, but become completely anonymous on the network after you have done so. This takes the strongest parts of both systems to create a hybrid that’s safer and more functional than the originals. Although it is not perfectly decentralized, this method provides added security as well as the anonymity of DeFi to its users. This bridging of technologies can particularly allow larger institutions to still provide quality and safe services to its users without completely compromising many of the DeFi principles.

The Future of DeFi and KYC

DeFi and KYC are like opposite ends of a magnet, but only time will tell how they will coexist as the lines of traditional and decentralized finance continue to blur. We have already started to see enterprises and banks become interested in providing their own version of “DeFi” that looks like a middle ground between the two. If these regulated entities want to provide DeFi, KYC will likely be a must to participate with them. Most believers in DeFi agree that this is not the true nature of the ecosystem, and is in fact another way to centralize and control money and assets. The DeFi community continues to look further into the future towards a truly decentralized financial ecosystem where access and equality of all people may finally be reached beyond the scope of institutions. In the meantime, the imperfect bridge between DeFi and CeFi via security practices may not be completely ideal, but is a great form of harm reduction as we all navigate through this next evolutionary step in crypto.

For more information on Shift Markets and our solutions, please visit our website. You can also contact us through our website, or reach out via Telegram channel and a team member will get in touch.

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SHIFT provides cryptocurrency exchange solutions, brokerage trading technology, liquidity, risk management, compliance, and marketing services for clients.

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Shift Markets

Shift Markets

SHIFT provides cryptocurrency exchange solutions, brokerage trading technology, liquidity, risk management, compliance, and marketing services for clients.

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